Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

Dividend Discount

Model

FCFE Model

Dealing

with cash

and

marketable

securities

The income from cash

and marketable

securities is built into

earningsand ultimately

into dividends.

Therefore, cash and

marketablesecuritiesdo

not need to be added in.

You have two choices:

1. Build income from
   cash and marketable
   securities into
   projections of income,
   and estimate thevalue
   of equity.
   2.Ignore incomefrom
   cash and marketable
   securities,andaddtheir
   valuetoequityvaluein
   model.

Ingeneral,whenfirmspayoutmuchlessindividendsthan
they have available in FCFE, the expected earnings and
terminalvaluewillbehigherinthedividenddiscountmodel,
buttheyear-to-yearcash flowswillbehigherintheFCFE
model.

What Does It Mean When They Are Different?

WhenthevalueusingtheFCFEmodelisdifferentfromthe
value using the dividend discount model, with consistent
growthassumptions,therearetwoquestionsthatneedtobe
addressed:Whatdoesthedifferencebetweenthetwomodels
tellus?Whichofthetwomodelsistheappropriateonetouse
in evaluating the market price?

ThemorecommonoccurrenceisforthevaluefromtheFCFE
modeltoexceedthevaluefromthedividenddiscountmodel.
ThedifferencebetweenthevaluefromtheFCFEmodeland